Why Obama's Small Biz Rescue Plan Is Collapsing

You might recall that a couple weeks back, the Obama Administration convened a "small business summit" to trumpet its efforts to shore up small business lending. Most notably, President Obama and Treasury Secretary Geithner determined that the Treasury Department would spend up to $15 billion to buy SBA-guaranteed loans. The idea was to loosen up SBA credit by unfreezing the secondary market for those loans; banks or middlemen who sell their loans to the government could then use the proceeds to make or buy new loans.

So what's happened with that initiative? Nothing, according to the Washington Post. "Every major provider of these kinds of loans," the newspaper reported on Wednesday, "says the plan will not work as designed."

The problem seems to be that the money for the program is to come from the Troubled Asset Relief Program, to which Congress has attached some strict ("onerous" is the adjective du jour) conditions. Institutions that sold SBA loans to the government would have to surrender an ownership share, too. And they'd face limits on the salaries and bonuses they could pay key employees. "Why would you participate?" Signature Bank CEO Joseph J. DePaolo asked the Post rhetorically. "How can you do business if the government at any time can change the rules of the game to protect its investment?" According to the article, Signature Bank is one of six broker institutions that together control 80 percent of pooling market, none of which plan to sell to the Treasury.

We should have expected this. Too many financiers, on Wall Street and Main Street alike, are eager for a helping hand from Washington, provided they don't have to give anything up in return. Not the indulgent compensation schemes that reward short-term results at the expense of long-term success. Not a share of the profits, even though taxpayers would eat the losses. "You need us," they are saying, "so you will fork over your money on our terms." And why not? They're certainly not obligated to sell their loans to the government.

The Obama Administration seems ready to capitulate. The Post says it's trying to work out a structure that evades the mandates from Congress -- for instance, chartering a special "vehicle" that would technically not be a government entity. This is a mistake. Why reward intransigence? Moreover, as Agenda reader "Frank" points out, a secondary market is not unconditionally a good thing. "If a lender knows that it can sell a loan as soon as the loan is made, do you think that loan will be underwritten with the same diligence as a non-SBA guaranteed loan held on that lender's books?" he's asked elsewhere. It was, after all, the secondary market that facilitated the residential mortgage meltdown. Now, "Frank" is an implacable SBA critic, and I've never seen evidence that pooled loans perform worse than portfolio loans. Still, it stands to reason that an unconditional market maker (particularly the government) could change a banker's risk calculations.

The Post story doesn't make clear why the Treasury couldn't simply elbow the poolers aside and buy the loans from the banks themselves, though presumably the banks, too, would chafe under the "onerous" rules. As an alternative, Slate BizBox columnist Marc Tracy wants the federal government to compel TARP recipients to lend to small firms. The Agenda is a big fan of BizBox, but finds this idea problematic: if the point of TARP is to replenish capital lost to risky loans and stabilize fragile banks, it hardly makes sense to demand risky new loans from those banks. (And in this economy, any small business loan is a risky loan.) Moreover, as Tracy notes, some banks, including Signature, are already returning TARP money to free themselves of government accountability. This new stricture would certainly drive more of those banks that could to reject TARP. That in turn would heap further stigma on the institutions that couldn't reject federal help while simultaneously (and perversely) forcing this lending on the banks least able to absorb the risk.

A better idea -- and one that Tracy finds his way to eventually -- is that if even a generous government guarantee won't induce small business lending, the SBA should, for the next several months, make those loans itself. The House of Representatives actually contemplated direct lending by the agency in its version of the stimulus bill. At the time, the Agenda was leery of expanding the SBA's mission when the agency can barely meet its obligations now. But we've come to prefer that to indulging the financiers' taste for structuring transactions on heads-I-win-tails-you-lose terms.

And in fact, there are a lot of out-of-work bankers right now who could help the SBA ramp up a provisional direct lending operation quickly and easily. Many of them are in fact already expert in the ways of the SBA, having until lately worked in the SBA loan divisions of commercial banks large and small. As of last November, SBA lending had lost more than a third of its jobs, according to an industry recruiter.

The most recent casualty is Community West Bank. In 2008, this little California-based bank wrote 62 SBA loans for $25 million, while expanding its reach to 20 states across the U.S. Earlier this week, industry analyst Coleman reported that Community West had changed its mind. By Wednesday, it had reduced its lending footprint to the Rockies and west, and halved its staff.